Accounting for Crises

1. Accounting for Crises • 2009 Global Issues in Accounting Conference • May 28 - 29, 2009 • Venky Nagar • Gwen Yu

2. Causes of Crises • Role of Public Information • Less noise in signals of fundamentals increases predictability of crises • Less noise in public signals allows for better coordination of higher order beliefs…… And thus, promotes self fulfilling crises

3. Timeline of standard models Initial Fundamentals Final Value

4. Timeline of coordination games Initial Fundamentals Coordinated Action (interim financing) Final Value (depends on both fundamentals and coordinated actions) Speculators’ beliefs - Other’s actions - Fundamentals

5. Intuition Each speculator has a dollar The project needs at least 30 percent of the speculators to contribute: this is public knowledge NYC clubs

6. Angeletos and Werning 2006 Multiplicity on x-axis

7. Angeletos and Werning

8. The genesis of these models Guillemin and Pollack “Differential Topology” p.35: “Transversality, an unintuitively formal notion, turns out to be all we can physically experience.” Debreu won the Nobel by copying this idea into economics.

9. Mas-Colell’s Micro Text

10. Multiplicity What breaks the link between fundamentals and outcomes? Utility functions that are not concave enough Incomplete markets (OLG) Coordination Externalities Financial Markets

11. Main Prediction • Realized public disclosure of fundamentals are more likely to predict crises in countries where these disclosure have low precision • Empirical Analysis • In-sample prediction • Control for country fixed effects and cross-sectional correlation • Extensive set of controls

12. Table 11: Crisis prediction of accounting signals for high vs. low accounting quality Model : : if country has high quality accounting information , 0 otherwise. : if country has low quality accounting information , 0 otherwise. (Continued)

13. Table 15: Crisis prediction of accounting signals in tradable vs. non-tradable sectors for high and low accounting quality sub-sample (Continued) Model : : if country has high quality accounting information , 0 otherwise. : if country has low quality accounting information , 0 otherwise.

14. Table 15: Crisis prediction of accounting signals in tradable sectors for high and low accounting quality sub-sample Model : : if country has high quality accounting information , 0 otherwise. : if country has low quality accounting information , 0 otherwise.

15. Summary of findings • Accounting signals of realized fundamentals (earnings, accruals and volatility) have in-sample power in predicting crises • Fundamentals are more important than self-fulfilling beliefs when accounting signals have low precision. • Results hold after controlling for previously documented leading indicators.

16. Why accounting information? • Key input into financial markets • Rich set of ‘accounting information quality’ measures • Precision metric is not influenced by underlying volatility - Variance in asset prices = noise variance + fundamental variance • Source of variation and statistical power • Legal institutions and standards • Reporting incentives • Unexplored to our knowledge

17. Background (1) (2) (3)

18. Empirical Approach • Construct a country level composite precision score of accounting information • Bifurcate the sample into high vs. low quality accounting information (cross country) • Test predictive power of realized accounting signals; earnings, accruals and volatility (within country)

19. Table 2: Crisis onset years and number of public firms,1976-2005 (Continued)

20. Table 2: Crisis onset years and number of public firms,1976-2005 (Continued)

21. Table 2: Crisis onset years and number of public firms,1976-2005 (Continued) (Continued)

22. Table 2: Crisis onset years and number of public firms,1976-2005 (Continued)

23. Key notion of accounting quality • Rational Investors want information on unrealized gains and losses (Accruals) • Write-offs • Credit sales • Misreporting • Causes of misreporting • Difficulty • Legal Regime • Variation in Accounting Quality (or Precision)

24. Table 3: Measures of accounting information quality [c = country, f = firm, t = year]

25. Table 3: Measures of accounting information quality(Continued) [c = country, f = firm, t = year]

26. Table 4: Countries’ average accounting information quality, 1981-2005 Panel A: Countries with high quality accounting information

27. Table 4: Countries’ average accounting information quality, 1981-2005 (Continued) Panel B: Countries with low quality accounting information

28. Table 5: Stability of accounting information across different legal institutions and over time Panel A: Country ranking of quality of legal institutions by accounting information quality

29. Table 5: Stability of accounting information across different legal institutions and over time Panel A: Country ranking of quality of legal institutions by accounting information quality

30. Table 5: Stability of accounting information across different legal institutions and over time (Continued) Panel B: Correlation of accounting information quality and legal institutions Panel C: AR(1) coefficients between the values of each accounting quality measures over non-over lapping consecutive periods

31. Table 6: Descriptive statistics of leading indicators Panel B: Descriptive statistics of leading indicators

32. Table 6: Descriptive statistics of leading indicators (Continued) Panel B: Descriptive statistics of leading indicators

33. Table 7: Descriptive statistics of country characteristics Panel A: Countries with high quality accounting information

34. Table 7: Descriptive statistics of country characteristics(Continued) Panel B: Countries with low quality accounting information

35. Table 8: Descriptive statistics of realizedaccounting signals Panel B: Descriptive statistics of realized accounting signals

36. Figure 1: Realized accounting signals before and after 39 crises

37. Figure 1: Realized accounting signals before and after 39 crises

38. Table 10: Multivariate analysis of crises prediction Model: (Continued)

39. Table 10: Multivariate analysis of crises prediction (Continued)

40. Table 11: Crisis prediction of accounting signals for high vs. low accounting quality Model : : if country has high quality accounting information , 0 otherwise. : if country has low quality accounting information , 0 otherwise. (Continued)

41. Table 11: Crisis prediction of accounting signals for high vs. low accounting quality (Continued)

42. Takeaway • Implications of Timing • Power Issues

43. Table 12: Crisis prediction of individual accounting signals for high vs. low accounting quality Model: : if country has high quality accounting information , 0 otherwise. : if country has low quality accounting information , 0 otherwise.

44. Table 13: Institutional factors and endogenous policy effects Panel A: Crises and law enforcement from 1981 to 2005 : if country rank of law enforcement is below the sample median, 0 otherwise. : if country rank of law enforcement exceeds the sample median, 0 otherwise.

45. Table 13: Institutional factors and endogenous policy effects (Continued) Panel B: Crises prediction for the time varying (across 5-year non overlapping periods) high vs. low accounting quality sub-samples from 1981 to 2005 : if is below the corresponding period’s sample median : if exceeds the corresponding period’s sample median, else 0.

46. Table 14: Sensitivity Analysis Panel A: Crises prediction of 32 banking crises from 1981 to 2005

47. Table 14: Sensitivity Analysis (Continued) Panel B: Crises prediction with alternative classification for Italy and Thailand

48. Table 15: Crisis prediction of accounting signals in tradable sectors for high and low accounting quality sub-sample Model : : if country has high quality accounting information , 0 otherwise. : if country has low quality accounting information , 0 otherwise.

49. Table 15: Crisis prediction of accounting signals in tradable vs. non-tradable sectors for high and low accounting quality sub-sample (Continued) Model : : if country has high quality accounting information , 0 otherwise. : if country has low quality accounting information , 0 otherwise.

50. Takeaway • Martin & Rey (2006) : Crises triggered by the domestic sector are based on fundamentals • Evidence of self-fulfilling crises only in the tradable sector